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What Factors Are Considered In A Small Business Valuation?

Posted By: Peter Siegel MBA: BizBen Founder, Lead Advisor

Valuing a small business is not guess work. It's not what some other businesses of the same type may have or may not have been sold for, it's not even what a business owner "feels" they want or deserve. It is a formula based on many factors. Peter Siegel, MBA from BizBen & others discuss this topic.

Tags: business valuation, buying a business, due diligence, selling a business

Valuing a business is not guess work. It's not what some other businesses of the same type may have or may not have been sold for, it's not even what a business owner "feels" they want or deserve. It is a formula based on many factors, some of them internal and related to the specific business being valued, and some of them external and related to the market and the economy.

Having an in depth analysis of all pertinent factors done by a professional is so necessary and valuable to determine an accurate opinion of value.

Some of the internal factors that are taken into consideration are:

(1) historical performance;
(2) longevity and stability of the business;
(3) financial strength;
(4) profitability and earnings;
(5) discretionary cash flow;
(6) ownership and management strength and structure;
(7) operational structure and controls;
(8) size of operation, market share, and customer base;
(9) forecast and future projections;
(10) condition of the operation;

Some of the external factors that are considered are:

(1) the performance of the company compared to standard performance within the industry; (2) size of operation relative to the industry;
(2) its rank or position within the industry;
(3) its position within its market;
(4) industry trends;
(5) competition;
(6) economic factors
(7) government regulations

As you can see there are numerous factors that need to be analyzed in order to perform a formal valuation. Because it must be objective the use of an independent, qualified third-party valuation resource is essential.

Contributor: Due Diligence, Valuations Advisor

The methodology to use and the rules that apply are impacted by the purpose of the valuation. For example, if the purpose of the valuation is to support a minority shareholder action the standard of value may be fair value, which is different from the fair market value standard used in determining the value of a gift of stock. However as we are on a business sales website we will narrow the discussion to how to value a business for sale.

What you don't want to do is the A X B approach ( Sellers Discretionary Earnings X Multiplier). Anybody can do this and it works I suppose for a very small business. However in the middle market more is required.

The benefit stream I like to use is free cash flow , Hopefully a history is available that will support a consistent growth rate to use in the cash flow model. Be wary of projections.

Then develop a defensible discount/capitalization rate by using a build up methodology. The internal and external factors previously mentioned are useful for the subjective( specific company risk) part of the build up.

Having developed a value this way then comparable market data is useful and occasionally the value of the underlying assets can be used, particularly if the company has intangibles like patents owned.


Valuing businesses is so much more complicated than just referring to standards in a book or even getting comp information from the web sources. Sometimes it goes beyond given special circumstances that are specific to the area. A good example of what I'm referring to is the desirability factor. After selling business for 11 years I've learned what will sell and how much it will sell for depending on more than just the cash flow. The first broker i ever worked for said, "A business will sell for whatever a buyer is willing to pay for it." That is still true today, I have sold businesses with zero cash flow for hundreds of thousands of dollars and I have no luck selling some businesses with hundreds of thousands of dollars of cash flow because what type of business they were and where they were located. That's why its important to have a solid exit strategy from an experienced broker that can give you a realistic time frame & value to exit your business.

Contributor: Transactional Attorney

Having started and sold a company I grew to #25 on the Inc. 500 and bought (and later sold) a much smaller business, as well as representing both buyers and sellers in a wide range of industries, I could not agree with Christina more. A business is worth what a buyer will pay for it.

In small business transactions this is even more true. The factors that are important to one buyer may not be important to another, and the personal value the business brings to a given buyer is what determines the price they'll pay.

For example, some buyers may want a business that's absentee-owned while others want the opportunity to be directly involved in the day-to-day. And what may be a flaw to some buyers, such as a business that's open odd hours, may be a great fit for someone who wants to work those hours.

While valuation experts can provide a general range, there are no formulas or even rules of thumb that can effectively account for all the quirks that make up a small business valuation.

Contributor: Due Diligence, Valuations Advisor

Without question what a buyer pays for a particular business is determined by his or her strategic interest , personal lifestyle , and the outcome of negotiation. This determines the transaction value in a single transaction and becomes known at the end of the process.

Sellers want to know what their business is worth (hypothetically) before going to market and buyers need to benchmark to the fair market value, before deciding if their strategic interest supports paying more.

If I manage to offload my 2004 Lexus for $20,000 to somebody that just has to have it, that is the transaction value and gives little or no guidance to the world as to what people will pay for this kind of asset.

Most small business sales are at an advertised price . This has to be determined before the fact, using hopefully something other than the A x B methodology that is the standard fare of too many brokers.


An observation regarding Dave MacMillan's analogy --

If several people are willing to pay $18,000, $20,000, $22,000 for a 2004 Lexus then that does establish what the market will bear, despite any other determination of the car's intrinsic value. I agree that if most people are paying $15,000 for a 2004 Lexus and there is one outlier at $20,000, then the typical buyer in the market values a comparable Lexus at $15,000, not $20,000. But, if the "expert" determines that the 2004 Lexus is worth no more than $15,000 because of whatever criteria that expert is applying, and the mode (most common) purchase price is $20,000, then the "expert" is wrong and the market is right.

The same dynamic is true for businesses--the "value" of a business is determined by a complex variety of factors, unique to each buyer. It's not simply applying a formula, or a percentage, or a ratio; and, ultimately it is determined by an arms-length transaction between a willing and able buyer and is a willing and able seller.

Contributor: Business Appraisals, Valuations Advisor

Appraisal Requirements

For an appraisal system to work it must address the following:

1. the profitability of the business
2. the tangible assets of the business
3. the presence of intangible assets
4. the value derived should represent the market value
5. have flexibility to allow for the terms of a sale.
6. simplicity - Usable and understandable.

The first step was to determine what components in a business have value. These are some of them:

1. a functioning business with modest growth
2. skilled employees
3. working equipment
4. adequate usable inventory
5. a quality product or service
6. a profit
7. collectible receivables
8. a broad customer base with no very large customer
9. some new product development capabilities
10. a good reputation (name) in the market place
11. a clean, adequately sized work area
12. a financially sound operation with a good accounting system
13. the business located correctly for its market place
14. a good base of suppliers

After building this list it has to be divided to fall into a profit/asset based appraisal system. They are categorized as follows:

1. Profit based items.
a. business profit
b. a functioning business
c. business size - gross sales
d. intangible assets

1. skilled employees
2. a quality product or service
3. a broad customer base - customer list
4. new product development capabilities
5. a good reputation - business name
6. good financial management

2. Asset based items:

a. inventory
b. equipment
c. receivables
d. contracts
e. patents
f. trademarks
g. real estate

Contributor: Business Appraisals, Valuations Advisor

Over the years I have seen many appraisals from many different appraisers. I have been totally surprised by the wide variations of methods and the accuracy of these appraisals.

Appraising businesses accurately is not an easy task. There are about five different methods that can be used along with variations in the purpose of the appraisal. None of these methods addresses the total value of a business by its self. One method might look at cash flow value another at asset value and another at a capitalization rate. It is up to the appraiser to pick the appropriate method or give each of the methods used a percentage of the final value. Purpose also changes, as an appraisal done for the sale of a business will be different than one done for a divorce. Also, the IRS has certain requirements that must be followed for any appraisals submitted to them for such things as change in corporate structure or family trusts.

Financial statements and tax returns can create problems. Financial statements are always different, and tax returns don't always match the financial statements. I can spend hours going through the documents, talking to the business owner or the business' accountant looking for answers. To do an accurate job on the appraisal I have to understand these documents completely and how they relate to each other.

There is a wide variance in the quality of business appraisals mostly because of lack of experience. It is easy to pick up an accounting book and find the different methods of doing an appraisal, picking out a formula and plugging in some numbers. This process doesn't necessarily give you an accurate appraisal. Most accountants know this and turn to an experienced Business Appraiser for an appraisal. Also, be aware that there are appraisers that stuff the appraisal with irrelevant and highly technical information to exaggerate the complexity of the appraisal or over inflate the appraisal to make an owner feel he has a high value business. With a growth in the internet, we now see "fill in the blanks do it yourself" business appraisals. It is not possible to get an accurate business appraisal this way. There is no way to provide a short cut to an accurate business appraisal.

I use a blended method of appraisal consisting of cash flow, asset value and market analysis. This blended method evaluates all items that create value in a business. I never have to guess if I am using the correct method or find percentages to use for each component.


Another factor to consider in a business valuation is the purpose for which the valuation is being assessed. It could be for a potential purchase, for settlement of litigation (e.g., divorce, bankruptcy), for evidence in contested litigation, for purchase-money financing, for re-financing, for dissolution of a business, for merger into a strategic buyer, for retirement or tax purposes. In each of these circumstances, the process can be more or less complex, and the accuracy more or less critical.

In each instance, however, the purpose should primarily be to determine the "fair market value" (FMV) -- the price that a ready, willing, and able buyer will pay and that a ready, willing, and able seller will accept in an "arms-length" deal. Secondarily, the assessment can determine the intrinsic value to a specific buyer based on his/her particular circumstances and needs -- and this value may be significantly different from the FMV.

And, it's not simple. There are many factors to be considered and to be verified; and while "comparables" are useful, they are in no way as definitive or as helpful as they are in valuing commercial or residential real estate.


When I am assessing the value of a business, one of the most important steps in analyzing the profit and loss statement and balance sheet of the company. It's a complex process of comparing trends over time, regarding gross revenues, gross and net profits, cash flow, inventories, asset values, etc., etc. In addition, I want to compare all of these to other businesses in the same category. The best tool I have found and use regularly is from Finagraph in Seattle. It's free to business owners (banks have to pay for it) and can be really useful in improving the financial management of a business, in increasing its actual value, and in determining value for a potential buyer.



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